Even after a year when everyone from Wall Street financiers to late night TV hosts got into NFTs (non-fungible tokens), what do people really know about NFTs?
Often the media portrays NFTs as a sort of digital collectible and a way to own an image. For this reason, NFTs are sometimes mocked as putting a “JPEG on the blockchain”. Some question the value of this type of ownership since the blockchain cannot control who sees or shares a JPEG image.
The criticism is understandable, but reflects a misunderstanding of NFTs, how they open new possibilities for the web, and where their value lies. To begin, we need to discuss “smart contracts” and how they are involved in creating NFTs.
An NFT comes into existence when someone posts on a blockchain a smart contract that tracks the ownership of a set of virtual items or “tokens”. Smart contracts can store data on the blockchain and provide “functions” that are used to access or change the stored data. Smart contracts for NFTs follow standards that define the functions that should be provided.
Ethereum’s NFT standard requires an ownerOf function that returns the owner of a particular token. This is a key responsibility of NFT contracts: storing the owner of a token and retrieving it on request (for other contracts or anyone with access to the blockchain).
The standard also describes a tokenURI function, which provides data about the token. This usually includes the artwork (image or other media), name, and characteristics of the token. When an NFT’s art is displayed in the media or on a website, the art was ultimately found by using this tokenURI function.
One characteristic of owning an NFT is that the NFT’s contract identifies you as the owner. Anyone can confirm who owns a token by using the contract’s ownerOf function. Being able to retrieve the owner’s wallet address from this function demonstrates that the NFT contract has recorded the ownership of the token on the blockchain.
NFT owners expect that the contract recognizes them as an owner until they transfer or sell the token. Likewise, they expect that the token’s art, name, and characteristics do not change unexpectedly. Blockchains and smart contracts are important for providing this data reliability. Blockchains have rules for how data can be changed, and contracts provide a limited set of actions that can take place with the tokens. To increase trust in NFT contracts, it is important that NFT creators make contracts open source and reviewable by anyone, keep contracts simple, and involve third parties in reviews or audits.
There are many ways to get an NFT: they can be bought on a marketplace, received as a gift, or “minted” when first launched. All of these options involve using a contract’s functions to change the ownership records for the token.
Generally NFT contracts allow token owners to transfer their token to others. The Ethereum standard requires one function for an owner to send an NFT to another address and one function to allow a third party (usually a marketplace) to facilitate the exchange of a token. NFT contracts also need to provide a way for tokens to come into existence. This can happen when the contract is first created or when a “mint” function is used.
Owning an NFT is not valuable only because you are recognized as the owner of a token; owning an NFT allows you to do things with your token.
First, the contracts that create NFTs can provide functions that owners can use. The most common functions allow the owner to transfer a token, to “stake” or deposit a token, or to “burn” or destroy a token. Depending on the NFT’s design, these actions may benefit the owner by enhancing the owner’s token or by earning rewards (like cryptocurrency).
Second, smart contracts may grant special privileges to owners of certain tokens. Some NFT contracts allow owners of other NFTs to “claim” a token for free, at a reduced cost, or before the general public. Some contracts allow owners to lend a token in return for interest payments.
Third, websites and applications can grant special access to NFT owners. For example, online publications can sell NFTs that represent subscriptions, and then require ownership of this token to access premium content. Games may allow players to use their NFT’s art to personalize their in-game character.
Finally, owning an NFT can provide benefits in the real world. Just as many events use a QR code as a ticket, an NFT could be used as a ticket. An NFT could also be used to complement a physical product. For example, the purchase of an NFT from a shoe manufacturer could allow the owner to claim a pair of shoes as a reward. Furthermore, NFTs can be used in legal contracts to determine rights, such as licensing use of artwork or content.
For an NFT to exist, there is a smart contract that is responsible for storing the owner and characteristics for each token. The contract may allow owners to exchange tokens and take other actions. Owning a token can also provide benefits beyond those in the original contract and outside the blockchain.
One analogy for NFTs is real estate. People buy and sell property, and these transactions are recorded by the government to track ownership. With NFTs, people buy and sell tokens, and these transactions are recorded on the blockchain. When one buys an NFT or a house, one selling factor is what is most tangible: the NFT art or the building. However, the ground on which the asset sits - the land or smart contract - is just as important. An NFT’s contract determines what is owned now, why it holds value, and how it can be built upon in the future.
NFTs can provide a new ground for building online and offline experiences that allow people to express their identity, safeguard resources, and support artists and creators.